French, Germans Consider Major Overhaul of EU

BRUSSELS, Nov 9 - German and French officials have discussed plans for a radical overhaul of the European Union that would involve establishing a more integrated and potentially smaller euro zone, EU sources say.

French President Nicolas Sarkozy gave some flavour of his thinking during an address to students in the eastern French city of Strasbourg on Tuesday, when he said a two-speed Europe -- the euro zone moving ahead more rapidly than all 27 countries in the EU -- was the only model for the future.

The discussions among senior policymakers in Paris, Berlin and Brussels go further, raising the possibility of one or more countries leaving the euro zone, while the remaining core pushes on towards deeper economic integration, including on tax and fiscal policy.

News of such a plan sent the Dow down 3.6 % midday, the largest drop since a two-day slide began Oct. 31.

A senior EU official said changing the make-up of the euro zone has been discussed on an "intellectual" level but had not moved to operational or technical discussions, while a French government source said there was no such project in the works.

Such steps are also opposed by many EU countries, whose backing would be needed for any adjustments to the bloc's treaties, making them anything but a done deal.

"This will unravel everything our forebears have painstakingly built up and repudiate all that they stood for in the past sixty years," one EU diplomat told Reuters. "This is not about a two-speed Europe, we already have that. This will redraw the map geopolitically and give rise to new tensions. It could truly be the end of Europe as we know it."

Nonetheless, the Franco-German motor has generally been the driving force in steps forward for European integration.

To an extent the taboo on a country leaving the 17-member currency bloc was already broken at the G20 summit in Cannes last week, when German Chancellor Angela Merkel and Sarkozy both effectively said that Greece might have to drop out if the euro zone's long-term stability was to be maintained.

But the latest discussions among European officials point to a more fundamental re-evaluation of the 12-year-old currency project -- including which countries and what policies are needed to keep it strong and stable for the next decade and beyond -- before Europe's debt crisis manages to break it apart.

In large part the aim is to reshape the currency bloc along the lines it was originally intended; strong, economically integrated countries sharing a currency, before nations such as Greece managed to get in.

"France and Germany have had intense consultations on this issue over the last months, at all levels," a senior EU official in Brussels told Reuters, speaking on condition of anonymity because of the sensitivity of the discussions.

"We need to move very cautiously, but the truth is that we need to establish exactly the list of those who don't want to be part of the club and those who simply cannot be part.

"In doing this exercise, we will be very serious on the criteria that will be used as a benchmark to integrate and share our economic policies."

One senior German government official said it was a case of pruning the euro zone to make it stronger.

"You'll still call it the euro, but it will be fewer countries," he said, without identifying those that would have to drop out.

"We won't be able to speak with one voice and make the tough decisions in the euro zone as it is today. You can't have one country, one vote," he said, referring to rules that have made decision-making complex and slow, exacerbating the crisis.

Speaking in Berlin on Wednesday, Merkel reiterated a call for changes to be made to the EU treaty -- the laws which govern the European Union -- saying the situation was now so unpleasant that a rapid "breakthrough" was needed.

"The world is not waiting for Europe," she said in comments that focused on treaty change but hinted at more fundamental shifts. "Because the world is changing so greatly, we have to make a mental decision to find an answer to the challenges."

From Germany's point of view, altering the EU treaty would be an opportunity to reinforce euro zone integration and could potentially open a window to make the mooted changes to its make-up.

EU officials have told Reuters treaty change will be formally discussed at a summit in Brussels on Dec. 9, with an 'intergovernmental conference', the process required to make alterations, potentially being convened in the new year, although multiple obstacles remain before such a step is taken.

ACCELERATION

While the two-speed Europe referred to by Sarkozy is already reality in many respects -- and a frustration for the likes of Poland, which hopes to join the euro zone -- the officials interviewed by Reuters spoke of a more formal process to create a two-tier structure and allow the smaller group to push on.

"This is something that has been in the air for some time, at least in high-level talks," said one EU diplomat. "The difference now is that some countries are moving forward very quickly ... The risk of a split, of a two-speed Europe, has never been so real."

In Sarkozy's vision, the euro zone would rapidly deepen its integration, including in sensitive areas such as corporate and personal taxation, while the remainder of the EU would be left as a "confederation", possibly expanding from 27 to 35 in the coming decade, with enlargement to the Balkans and beyond.

Within the euro zone, the critical need would be for core countries to coordinate their economic policies quickly so that defences could be erected against the sovereign debt crisis.

"Intellectually speaking, I can see it happening in two movements: some technical arrangements in the next weeks to strengthen the euro zone governance, and some more fundamental changes in the coming months," the senior EU official said.

But he cautioned: "Practically speaking, we all know that the crisis may deepen and that the picture can change radically from one day to another."

France and Germany see themselves as the backbone of the euro zone and frequently promote initiatives that other euro zone countries reject. The idea of a core, pared-down euro zone is likely to be strongly opposed by the Netherlands and possibly Austria, although both would be potential members.

"This sort of thinking is not the direction we want to go in. We want to keep the euro zone as it is," said a non Franco-German euro zone diplomat.

Britain, which is adamantly outside the euro zone, is also opposed to any moves that would create a two-speed Europe, or institutionalise a process even if it is already under way.

"We must move together. The greatest danger we face is division," Britain's deputy prime minister, Nick Clegg, said during a visit to Brussels on Wednesday.

"That is why, while the United Kingdom fully supports deeper fiscal integration within the euro zone to support monetary union, we would not wish it to become a club within a club.

"To retreat from each other now would be to leave ourselves isolated in extremely tempestuous times." (Additional reporting by Robin Emmott and Luke Baker in Brussels, writing by Luke Baker, editing by Mike Peacock)